1. Use the FE-IS-LM diagram to illustrate the effects (in the short-run and long-run) of each of the following on the general equilibrium values of the real wage, employment, the real interest rate, consumption, and the price level:
(a) the expected future marginal productivity of capital rises;
(b) government bonds are now accepted as payment in transactions;
(c) there is a temporary positive supply shock;
(d) there is a stock market crash.
2. Consider the following Keynesian economy,
Cd = 500 + 0.5(Y-T+TR) - 250r L = 0.4Y - 300r Id = 250 - 355r M = 80000 NX = 250 - 0.07Y - 500r Yf = 1900 T = 200 TR = 50 G = 200
where Yf is the full-employment level of output.
(a) Find the general equilibrium values of output, the real interest rate, consumption, investment, net exports, and the price level.
(b) Suppose the government decides to double its transfer payments i.e. (TR=100). Find the general equilibrium values of output, the real interest rate, consumption, investment, net exports, and the price level.
(c) Suppose that the money supply falls by 10%, starting from case (a). Find real money demand and the price level.
3. Consider the following closed economy
Cd = 140 + 0.8(1-t)Y - 600r Id = 140 - 600r L = 0.25Y - 400i Yf = 1200 t = 0.25 G = 150 M = 23555
where Yf is full-employment level of output and the expected inflation rate is 0.10.
(a) Find the general equilibrium values of Y, r, C, I, real money demand and P.
(b) Suppose that government purchases fall to 100. Find the general equilibrium values of r, S, real money demand and P.
(c) Suppose that expected inflation rate rises to 0.15, starting from case (a). Find the general equilibrium values of real money demand and P.
4. Consider the July 1981-November 1982 recession in Canada. Use the CANSIM database to find the following series for the 1980 to 1982 period: M1 (B1627), stock exchange price indexes (B4290) and industrial production (I37035). Convert the data to `quarterly' frequency using the `average' method.
(a) Was the money growth rate a leading indicator of the recession? [Use data from at least 3 quarters prior to the recession]
(b) Were stock prices a leading indicator of the recession in 1981 and of the recovery in 1982? [Use data from at least 3 quarters prior to the recession and 3 quarters prior to the recovery. Select the `Plot a CANSIM series by Label' option on the CANSIM screen]
(c) Compare the drop in industrial production during the 1981-1982 recession with that of the 1974-1975 recession.
5. Between 1993 and 1994 the US/Canadian nominal exchange rate fell by 5.56%. Over the same period the Canadian inflation rate was 0.7% and the US inflation rate was 2.1%.
(a) Calculate the percentage change in the real exchange rate.
(b) Suppose that in 1995 the Canadian inflation is expected to rise to about 2.3%, the Canadian dollar is expected to fall by 1.69% and no change is expected in the US inflation rate. What will be the percentage change in the real exchange rate?
(c) What should then happen to the trade balance?
6. Describe the effects of each the following on the the real exchange rate, the domestic (S-I), NX and IS curves:
(a) the US real interest rate rises;
(b) there is a fall in the domestic user-cost of capital;
(c) the domestic labour force increases;
(d) there is a fall in total domestic consumption.
7. The Canadian real exchange rate increased by about 20% between 1986 and 1989 and then fell by about 4.3% between 1989 and 1992. The table below gives export and import volumes in millions of constant 1986 dollars from 1986 to 1993.
Exports Imports
1986 120,318 110,371
1987 124,719 117,229
1988 136,280 133,813
1989 137,794 141,099
1990 144,114 141,529
1991 146,229 145,803
1992 158,089 156,559
(a) Calculate the percentage change in imports and exports between 1986 and 1989.
(b) Calculate the percentage change in imports and exports between 1989 to 1992.
(c) Do the above changes support the `beach-head effect'?
1. (a) IS shifts up and to the right as desired investment rises. Equilibrium Y is temporarily above its full-employment level so prices adjust upward. LM shifts to the left as prices rise to bring the economy back into general equilibrium. The long-run equilibriun real wage and employment are unaffected. The long-run equilibrium r and P are higher. The long-run equilibrium value of C is lower (S is higher) and that of I is higher (I increases at every level of r).
(b) LM shifts down and to the right as real demand for money falls. Equilibrium Y is temporarily above its full-employment level so prices adjust upward. LM then shifts up and to the left as prices rise to bring the economy back into general equilibrium. The long-run equilibriun real wage, employment, consumption, I and r are unaffected. The long-run equilibrium P is higher.
(c) Employment and real wage increase as MPN rises. FE shifts to the right as full-employment level of output rises. Desired savings rise and the real interest rate falls. IS is unaffected. Equilibrium Y is temporarily below its full-employment level so prices adjust downward. LM then shifts to the right as prices fall to bring the economy back into general equilibrium. The long-run equilibrium Y, C, I, real wage, employment are higher. The long-run equilibrium values of r and P are lower.
(d) LM shifts up and to the left as real demand for money rises. Equilibrium Y is temporarily below its full-employment level so prices adjust downward. LM then shifts to the left as prices fall to bring the economy back into general equilibrium. The long-run equilibriun real wage, employment, consumption, I and r are unaffected. The long-run equilibrium P is lower.
2.
(a) Y=1900, r=0.038, C=1365.5 , I=236.51 , NX=97.99, P=106.87.
(b) Y=1900, r=0.0606, C=1384.85 , I=228.49, NX=86.7, P=107.84.
(c) L=748.6, P=96.179.
3.
(a) Y=1200, r=0.078, C=957.02 , I=93.02 , L=228.68, P=103.
(b) r=0.0366, S=118, L=245.33, P=96.012.
(c) L=208.68, P=112.876.
4. (a) Ambiguous.
Money growth rate rises in 4th quarter of 1980 (1980.4), then falls during the 1st quarter of 1981 (1981.1) but rises again during the second one (1981.2), just before the recession began in the 3rd quarter (July 1981).Growth Growth M1 Rate (%) M1 Rate (%) 1980.1 24369.7 - 1981.1 25978.3 -1.42 1980.2 24330.3 -0.16 1981.2 26105.0 0.49 1980.3 25314.0 4.04 1981.3 26077.7 -0.10 1980.4 26352.3 4.10 1981.4 25383.0 -2.66
(b) Good indicator. Stock prices peak in the first quarter of 1981 (2 quarters before the recession began) and hit bottom in the second quarter of 1982 (2 quarter before the recovery began in 1982.4).
(c) Between 1981.3 and 1982.4, industrial production fell by 12.08%. Between 1974.2 and 1975.2, industrial production fell by 9.28%. The 1981-1982 recession was more severe than the 1974-1975 recession.
5. (a) -6.96%: the real exchange rate depreciated by 6.96% between 1993 and 1994.
(b) -1.49%: the real exchange rate is expected to depreciate by 1.49% in 1995.
(c) The trade balance should continue to improve (though perhaps more slowly) as the real exchange rate is expected to depreciate further in 1995.
6. (a) RER falls, NX and IS shifts to the right. (S-I) is unaffected.
(b) (S-I) curve shifts to the left and IS shifts to the right. NX and RER are unaffected.
(c) (S-I) shifts to the right. NX shifts to the left due to increased demand for imports. IS curve is unaffected. RER falls.
(d) (S-I) shifts to the right. NX shifts to the right due to fall in imports. The effect on the IS curve is ambiguous (could move up, down or be unaffected depending on the new value for r). RER rises.
7. (a) Exports: 14.5%; Imports 27.84%.
(b) Exports: 14.73%; Imports 10.95%.
(c) Yes. The growth rate of exports is about the same after the depreciation. Further depreciations are required for export growth to be significantly affected thereby improving the trade balance. Also imports continued to grow after the depreciation.